Theme 3 ( Need To Learn ) Flashcards
Principal-agent problem
Owners aim to maximise profits, workers aim to maximise personal benefit - workers acting on behalf of owners without their best interests
Advantages of vertical integration
Less risks, control of quality of supply, increased profit potential
Disadvantages of vertical integration
Lack of expertise in industry
Advantages of horizontal integration
Reduce competition, specialisation, expertise in area
Disadvantages of horizontal integration
Increased risk as investment all in one area
Conglomerate
Merger with a firm you have nothing in common with
Reasons for demergers
Diseconomies of scale, some areas costing outer areas, authorities over regulation
Impacts of demergers
Workers - promotion or loss of job, Business - Increase innovation or smaller EoS, Consumers - better products or greater price
Reasons for revenue maximisation
Managers/workers salary usually based off revenue, fall in revenue lead to a fall in staff, also greater quantity so EoS and lower price so discourages competition
Reasons for sales maximisation
Increased security of business, increase market share + can build customer loyalty, short-term strategy, represents limit pricing
Statisficing definition
Principal- agent problem, workers don’t profit-maximise but keep enough profits to keep owners happy
Internal EoS
Technical (production - machinery/specialisation), Financial (greater security+ investment more accessible), Risk bearing (able to take greater risks), Managerial (specialised managers), Marketing/Purchasing (bulk supply)
External EoS
Improved infrastructure, increased labour in area
Diseconomies of scale
Less motivation, geography, harder to control do-ordinate, harder to respond to change
Collusive behaviour
Collective agreement to reduce competition, reduces uncertainty of firms - works best in an oligopoly due to high barriers and high trust due to little firms
Overt collusion
Firms come to a formal agreement (illegal) - cartel behaviour
Cartel behaviour
Rules laid out in a formal document - either agree on price and compete on non-price competition or agree to divide market share
Issues with cartel behaviour
Incentive to break cartel as price/output not level firms would choose
Tacit collusion
Non-formal agreement (not illegal )
Examples of Tacit Collusion
Price leadership (large firms decide price, small firms follow to avoid price wars), Barometric Price leadership (firms gain reputation for being good at leading market )
Game Theory - Maximin policy
Firms work out strategy where worst possible outcome is the best - often used in oligopolies
Game Theory - Maximax policy
Firms working out policy with the best possible outcome
Issues with Game Theory
Always incentive to break game theory
Price wars
Occurs in markets where non-price competition is weak, firms make a loss in the short-run but some forced to leave in the long-run - loss of profits
Predatory pricing
Used to stop new firms entering the industry - established firms benefit from EoS - firms make loss + is illegal
Limit Pricing
Similar to predatory pricing but firms continue to make a profit
Price skimming
Once product launched, prices high to cover costs - after time price lowered
Penetration pricing
Prices low when enter market to encourage use, prices then raised
Natural monopoly
High start up costs, no need to encourage competition (rail)
Monopoly issues
May not always to profit maximise due to -x-inefficieny, hurts suppliers as monopoly also monopsony
Monopsony issues
Workers can be exploited due to 1 buyer of labour, consumers may suffer from lower quality
Different barriers to entry
Legal barriers (patents), predatory pricing/limit pricing, level of start-up costs and sunk costs
Wage determination in perfect competition
Wages purely determined off supply and demand
Wage determination in a monopsony
1 buyer of labour, can pay a lower wage and employ less
Labour monopoly
Trade unions fighting for higher wages and workers rights
Bilateral labour monopoly
Both a monopoly and monopsony in labour market, strength of each side determines wage
Issues of the labour market
Skill shortages, long-term education, retirement, wage inequality, 0 hour contracts
Positives of a minimum wage
Decreases inequality, higher productivity (motivation), prevents unemployment trap
Unemployment Trap
Wages so low people would rather stay unemployed and earn from benefits
Issues with a minimum wage
Increases unemployment, raises costs, regional differences, larger number on a minimum wage
Maximum wage effects
Leads to excess demand - but demand maybe inelastic due to higher skilled jobs effected, may lead to brain drain
Methods to tackle Geographical immobility
Increase supply of houses, improve transport links, subsidies on houses in the north, advertising
Methods to tackle occupational immobility
Increase training, encourage education, raise government spending
CMA
Uk based regulator, work on how to promote competition
Why do regulators investigate mergers?
Look at how much it will damage competition ( investigate if market share greater than 25% or combined revenue £700 million +) -CMA able to not approve a merger if it thinks consumers will be exploited
Ways regulators control monopolies
Price regulation to encourage efficiency, however difficult to set due to asymmetric information
Other methods regulators use
Quality standards set, performance targets set, windfall taxes, breaking up monopolies, reducing barriers to entry
Issues with performance targets
Firms likely to resist/fail to meet targets
Deregulation impacts
Removal of barriers to entry, increases competition and efficiency but may lead to poor firm behaviour
Competitive tending
Goods supplied to the public sector from the private sector- government requests a specification for a good the private firms bid for the contract
Advantages of privatisation
Greater competition so improved allocative efficiency and reduced x-inefficiency, reduces government interference
Disadvantages of privatisation
Abuse of monopoly power, problems over inequality, some firms should be nationalised (water) as other firms depend on their success, loss of economies of scale, no guarantee firms will enter immediately
Advantages of nationalisation
Guarantees a minimum level of service, maximise social welfare (natural monopoly) so allocatively efficient, long-term investment guaranteed, economies of scale,
Disadvantages of nationalisation
Principal-agent problem/moral hazard (managers know losses covered by government ), lack of efficiency causing prices to rise, diseconomies of scale, less profits, expensive (worsens deficit), political priorities override commercial issues
Regulatory Capture
Regulators are influenced by firms - leads to biased regulation
How could you reduce the principal-agent problem?
Managers given shares in the business, encourages them to make profits
What does PED tell us about the impact of taxes/subsidies?
Taxes- if PED is inelastic consumer pays more , producers profits increase (and vice-versa) Subsidies - if PED is inelastic consumer benefit more, producers profit decreases
What do the CMA mainly regulate?
Large scale Mergers, and if they will be beneficial to the industry - if the combined merger has over 25% market share or if their annual turnover is at least £70 million
Reasons firms grow
Economies of scale, more revenue, greater profits
Reasons firms don’t grow
Size of the market, access to finance, opener objectives, regulation
Advantages of organic growth
Firms keep control, less risk, cheaper
Disadvantages of organic growth
Slow, lack of innovation, unable to gain access to new markets
Advantages of a conglomerate
Room for growth in another market, reduces risk, easy for each part of the firm to grow
Disadvantages of a Conglomerate
No expertise in the industry which may be damaging to profits
Constraints on business growth
Size of the market (worse in a niche market), access to finance (banks less willing to lend to smaller firms + less retained profit), owner objectives (don’t want extra risk), regulation (CMA)
Why do business profit maximise?
Interests of owners/shareholders, provides funds for investment and helps them survive a slowdown during recession
Marginal revenue calculation
Change in total revenue divided by change in output
Impact of negative marginal revenue
Total revenue decreases as output increases, demand become inelastic
Total cost calculation
Fixed + Variable cost
AVC calculation
Total variable cost divided by output
AFC
Total fixed cost divide by output
Short-run cost
At least 1 factor of production is fixed
Long-run cost
All of the factors become variable
Diminishing Marginal Productivity
Extra output is decreasing by employing more labour (diseconomies of scale)
Shift in Average Cost
Taxes/technology/Eos or DEoS - changes in costs of production
Perfect competition efficiency
Allocatively and productively efficient, not dynamically efficient as small firms so lack of SNP (especially in the long-run)
Monopolistic competition efficiency
Firms not allocatively or productively efficient as aim to profit maximise and have some degree of price setting but firms may be dynamically efficient - however firms still small
What does Game Theory show in an oligopoly?
Shows why firms may break a collusion if there is an incentive to do so - dependent on risk
Oligopoly efficiency
Statically inefficient, however large SNP may mean firms are dynamically efficient
Benefits of price discrimination
Firms can increase profits for R and D, should reduce equality, allows survival of a product/service
Costs of price discrimination
Consumers with inelastic demand may be on lower income so worsens inequality
Benefits of a monopoly for the firm
Huge profits, firms finance for investments and build up a reserves for difficulties, benefit from EoS, international market
Problems of a monopoly for firms
Firms may not always profit maximise as are x-inefficient - profits may be increased if there is some level of competition
Benefits of a monopoly on workers
Due to the inefficiency of a monopoly employees receive higher wages
Issues of a monopoly on workers
Employ fewer workers, monopoly may also be monopoly in the labour market
Issues with a monopoly for suppliers
Monopoly may also had monopsony buying powers, supplies sold for cheap losing suppliers profits
Efficiency of a monopoly
A monopoly is statically inefficient, may be dynamically efficient however no incentive to invest to improve efficiency
Argument that monopolies will be efficient
Want to protect market share + if grown organically should be efficient
Characteristics of a contestable market
Perfect knowledge, freedom of entry/exit, low product loyalty, low sunk costs, available technology
Example of a contestable market
Hotel market, due to AirBnB
Implications of a contestable market
Firms use limit pricing, in a perfectly contestable market firms only make normal profits, firms will be productive and allocatively efficient
Barriers to entry in a contestable market
Economies of scale
Barriers to exit in a contestable market
Cost to write off assets, pay leases and make workers redundant
Sunk costs definition
Fixed costs a business can’t recover if leaves industry, all suffer sunk costs
Degree of contestability definition
Extent to which the gains from market entry for a firm exceed the costs of entering the market
Derived demand
Demand for labour comes from demand for the product
Factors influencing demand for labour
Wage rates, demand for product, prices of alternative wages in otherness countries, technology, regulation
Factors effecting the PED of labour
Directly correlated to the PED for product, proportion of wages to the total cost of production, substitutes, time (long-run more elastic as machinery is developed)
Factors influencing the supply of labour
Wages (backwards bending supply curve), population and distribution of age, non-monetary benefit (free childcare), education/training, trade unions, wages and conditions of other jobs, retirement age
Problems of immobility
Causes regional excess supply/excess demand of labour
Elasticity of labour supply
Responsiveness of supply to a change in wage rates - depended on the level of qualifications/training and availability of suitable labour in other industries, time of job, also vocational (I,e teachers)
When was the minimum wage introduced?
1999
What can the maximum wage cause
Excess demand for labour, also a brain drain
What is the argument a maximum wage has little impact?
Effects small amount of workers so has little effect on market, also not applicable so business owners
Short run public sector wage setting
Government makes whatever wage decisions it decides
Long-run public sector wage setting
Government forced to increase wages if private sector wages are higher
What did the government do between 2010-2015, and what impact did this have?
Public wage pay freeze, put downward pressure on private wages as firms could justify not raising wages
Issues with the CMA
Investigate very few mergers, can suffer from regulatory capture
How do the government use price regulation to control monopolies?
Use RPI-X formula, X represents expected efficiency gains for firms, RPI stands for retail price inflation - can also use RPI-X+K where K represents investment
What does price regulation do for firms?
Gives an incentive for firms to be efficient as if they can lower costs by more than X they can increase profits
What does price regulation on monopolies do for consumers?
Prevents excessive prices for consumers
Issues with using price regulation to control monopolies
Asymmetric information means it’s difficult to know where to set X (I.e Water companies forced to cut prices by 10% in 2000)
How can profit regulation be used to control monopolies?
USA rate of return regulation - encourages investment to increase profits
What are the issues with using profit regulation to control monopolies?
May leads to firms over employing to increase profits which causes inflation, also firms aim to profit maximise so may not be more efficient
What other regulations can be used to control monopolies?
Setting of quality standards and performance targets (I.e trains on time in Britain)
Issues with using performance targets to control monopolies
Firms will resist targets, change targets without improving(I,e trains change timetable so not late), if fines aren’t enough firms will just fail to meet targets
How can the government promote small businesses?
Training and grants to new entrepreneurs c use tax incentives/subsidies - increases innovation and efficiency
How can the government use deregulation to promote small businesses?
Removal of legal barriers to entry which improves efficiency (Deregulation Act 2015) but may lead to poor business behaviour
Issues with competitive tendering
Could reduce quality as private sector profit maximise, bidding can be time consuming
Enterprise Act 2002
Firms engaging in collusive behaviour or predatory pricing could be fined up to 10% of worldwide annual sales or cartels could face prison time ( Tesco fined £10 million in 2011 for fixing the prices of milk/eggs)
How can monopsony power be restrained?
Regulation, minimum prices for suppliers, trade unions
How can worker’s rights be improved
Through government (health and safety controls + contracts) and trade unions (increase wages)
Issues with trade unions
Increase unemployment
Impacts of government intervention in a market
Prevent exploitation of consumers, increase efficiency (dynamic) through investment
Issues with government intervention
Over regulation leads to costs rising which increases inefficiency
Issues with government run businesses
May suffer from x-inefficiency as not profit driven, offer less choice
Example of a regulatory capture
Capture of HRMC by Vodafone, managed to reduce tax on firm from £7billion to £1 billion in 2009-10
Problems with regulating due to asymmetric information
Industries provide the government less information so can’t regulate as well
Reasons why firms don’t profit maximise
Lack of knowledge of where MC=MR, principal-agent problem, avoid over regulation, upset stakeholders
Impact of profit maximising on consumers + effect of this in company?
Can lead to excessive prices - builds a bad reputation for the company
Impact of profit maximising on workers + effect of this on the firm?
Charged lower wages, can lead to strikes
Impact of profit maximising on workers + effect of this on the firm?
Can lead to lower wages - causes strikes
Impact of profit maximising on environment + effects of this on firm?
Cutting costs may cause damages to the environment I.e dumping waste - leads to bad reputation
Natural rate of unemployment definition
Unemployment that remains when the labour market is in equilibrium
Reasons for the natural rate of unemployment
Lack of skills, geographical immobility, waiting for better jobs, seasonal unemployed waiting for season labour to return
What does CMA stand for?
Competition and markets authority
Market failure linked to efficiency
When firms aren’t being allocative efficient there is some level of market failure
Characteristics of a natural monopoly
Huge fixed and start up costs, huge potential for economies of scale
Reasons it’s beneficial for only 1 firm in the industry in a natural monopoly
An additional firm wouldn’t benefit from Economies of Scale so wouldn’t be able to remain in the industry in the long run, causes a waste of resources - also competition ruins EoS exploitation of the existing firms
Why do natural monopolies need regulation?
Would charge very high prices with low quantity if not regulated - show on diagram
Reasons there is a lack of private sector natural monopolist
Natural Monopolies often only make normal profits as are forced to produce where AR=MC and then subsidised losses - lack of incentive for private firms to enter a little profit opportunities
Evaluation of privatisation
Depends on competitiveness of new private market, depends on regulation (lack of regulation creates monopolies)
Evaluation of nationalisation
Funding vs delivery of national company, competitiveness of market before nationalised, regulation more viable option
Reasons market isn’t allocatively efficient
Imperfect information, barriers to entry, irrational consumer behaviour
Trickle down effects
Higher wage earners spend money creating a multiplier effect and growing the economy, which creates wage improvements and labour opportunities for lower wage earners - also tax revenue can be redistributed to the poor
Arguments that wage differentials are good
Incentive to gain skills/qualifications, trickle down effect, encourages enterprise, reduces risk of unemployment trap as incentive for people to work as can earn high wages, promotes efficient resource allocation
Argument that wage differentials create issues
Creation of income inequality - reduces growth in the long run as those on higher incomes have lower MPC (also links to trickle-down effect not working), gov solutions are limited if they are the employer
Evaluations of wage differentials
Costs/benefits of income inequality, risks of government failure, Sr or Lr - better benefits in the long-run
Issues with state provision of goods
Creates excess demand as is free, high costs, government have imperfect information, inefficiency of the state
Remember with consumers/producers!
Consumers always above producers UNLESS it’s a subsidy
